In a landmark change of course, California has undercut a key employer practice, making it far more difficult for employers to utilize independent contractors within their business. On April 30, 2018, the California Supreme Court changed the independent contractor test in California, making it much easier for independent contractors to claim they were incorrectly labelled employees. Dynamex Operations West, Inc. v. Superior Court (2018). This significant change is likely to create enormous liability for many companies that utilize independent contractors as a substantial factor in their California workforce. Many employers may be compelled to reclassify independent contractors they utilize as employees at their own great expense. No one may be hit harder than national businesses that have been utilizing independent contractors to circumvent California employee friendly statutes.

It is hardly secret that many businesses depend on the use of independent contractors to handle many aspects of industry outside of their own expertise. However, many corporations also take advantage of the “independent contractor” designation as a means to pay less and get more from workers that should properly be considered employees.

And why should businesses classify workers as employees when they can get away with clarifying them, or misclassifying them, as independent contractors? Well, the answer is simple. Workers who are not employees are not entitled to a number of benefits that regular employees would receive, including health, FMLA, retirement, unemployment or a number of other benefits, and that means a substantial savings to the employer. Unfortunately, for the worker, this means a small economic incentive at the cost of giving up benefits that few truly appreciate at the time of the bargain.

For decades, California courts had applied a flexible test to determine a worker’s proper designation instituted by the California Supreme Court in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989). The Borello test, widely considered to be more advantageous to employers, established a number of factors to determine whether an individual should be classified as an employee or independent contractor, with the paramount consideration being the right or amount of control the employer can exercise over the worker. As the California Supreme Court explained, the “individual factors cannot be applied mechanically as separate tests; they are intertwined and their weight depends often on particular combinations.” Borello, supra, 48 Cal.3d at 351. This flexibility empowered employers to craft contracts intended to establish independent contractors rather than employees.

The California Supreme Court in Dynamex, however, outright rejected the Borello test in favor of what it described as a “simpler, more structured test,” commonly referred to as the “ABC” test. This test, already utilized in many jurisdictions outside of California, is modeled on the Massachusetts independent contractor statute, which is considered by many to be the strictest in the country. The test begins with a presumption that the worker is an employee, and will only be considered an independent contractor if the hiring entity can establish three certain requirements:

A) The worker must be “free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.”
B) The worker must perform “work that is outside the usual course of the hiring entity’s business.”
C) The worker ‘is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

Given the origins of the “ABC” test and its applications, the California Supreme Court’s departure from substantial precedent is clear – independent contractors are the exception, not the rule. Now, employers must decide how to adjust.

Unsurprisingly, the biggest impact by the California Supreme Court’s decision is cost – both increased labor costs and litigation. Most employers that have exploited the independent contractor designation have done so for one simple reason – it saves them money. As the California Supreme Court identified, there are many incentives for a business to designate a worker as an independent contractor including a competitive advantage over other businesses that correctly classify their workers. Moreover, Federal and State governments claim that the misclassification of workers deprives them of billions in tax revenue. That revenue is largely pocketed by the employers and that is where the increased costs will hit. It is a matter of common sense, however, that big businesses will not simply eat these costs themselves, so expect increases in prices everywhere from produce to shipping to Uber rides.

Increases in costs won’t just stop there. Businesses utilizing independent contractors should also expect substantial increases in litigation. Wage and hour class actions are likely to rise substantially based on violations for improperly classified workers. Although the California Supreme Court’s ruling technically only applies to Industrial Welfare orders (which include minimum wage, rest breaks, meal periods and overtime regulations), expect to see this test applied to all areas of employment litigation. Taking into account the benefits already provided for successful employment actions (such as attorney fee provisions), employment plaintiffs’ attorneys will be looking to bring these wage and hour actions en masse and as representative actions, where possible. Even workers that may rightly have been deemed to be independent contracts may try to take advantage of the change and public policy ramifications to receive settlements – as the cost of defense will likely outweigh the amounts in controversy.

Now that businesses and employers feel sufficiently disenfranchised, and rightly so, they should turn to potential answers and solutions. As a preliminary matter, the California Supreme Court’s decision suggests that all employers with independent contractors in California at least review their policies and agreements with an eye towards satisfying the three-factor test. Uncertainty and ambiguities should be assumed to not satisfy the test.

If an employer has used, or is using, independent contractors, each must ultimately make its own risk/reward analysis to determine whether to keep utilizing independent contractors or make the transition to employees, and whether to remedy potential past violations. However, given the litigation costs for improperly designating an independent contractor, along with the presumption that the worker will be deemed an employee, most businesses should only utilize independent contractors moving forward in the clearest of settings or be prepared to fight the lawsuit that will likely be filed at some point or another.

Additionally, employers should look to other areas of protection such as arbitration agreements and, so long as they remain valid, class action waivers. These efforts can help limit the potential exposure for employers utilizing independent contractors.

It is too early to see how California courts will apply this new test, but most small to midsize employers cannot afford to be the early lab rats. Therefore, employers should take steps immediately to try and determine any violations and resolve them, even if it means eliminating the use of most independent contractors altogether in favor of a traditional employee workforce.